It has been three years since the start of the pandemic, and the global economy has been through a series of unexpected and hugely impactful disruptions. Over the past year alone, we witnessed the biggest surge in inflation in 40 years, a very rapid tightening of monetary policy, significantly increased risk of recession, the biggest land war in Europe since the 1940s, massive disruption of supply chains, a serious shortage of labor in many countries, commodity-market volatility, and a growing debate about the future of globalization.
As we enter 2023, many questions arise. Will inflation recede? Which countries will experience recession? Will supply chains improve? Will labor market tightness continue? And, very importantly, what is the outlook for each of the world’s major economies?
In the pages that follow, we attempt to answer some of these questions, tapping into insights from Deloitte economists across our member firms worldwide. We hope that our clients—especially those with a global reach—will find this set of brief analyses to be useful and insightful. And we hope that our readers will click on the links to more in-depths reports from each of these countries. Finally, your feedback on this—our first such global endeavor—will be most welcome.
Best regards,
Ira Kalish
Is a recession on the horizon? That’s been a key question for the US economy for the past six months. So far, it’s safe to say that the recession is mostly in people’s minds. Sentiment data has been very negative even as actual economic activity—as measured by job gains, industrial production, and retail sales—are still indicating growth.1 But the question about whether there might be a recession is not really the right one to ask. The Fed has hiked the funds rate by 300 basis points since March of this year, and 10-year bond yields are 4%, over twice the level at the beginning of the year. This suggests that economic activity will continue to slow over the next six months. The Deloitte forecast shows very slow growth in the first half of 2023—but not enough to cause a recession.
There are plenty of reasons to expect a slowdown. The vulnerability of Europe to Russian energy sanctions, China’s housing market problems, and the impact on global food supplies because of continued war in Ukraine are all significant headwinds. But the US economy is not as exposed to these problems as many analysts assume. International trade is a modest share of the US economy, with much of the trade taking place within North America. And the substantial US energy and food sectors stand to gain from higher prices for commodities. (In the case of energy, global oil prices are already coming down.)
The real case for a recession in the United States involves the Federal Reserve’s actions to slow the economy. And there are a couple of reasons why the slowdown is not as likely—as some analysts claim—to turn into a full-fledged recession:
The Fed’s tightening cycle has been fast. But it’s still slower than the last Fed-created recessions (in 1980 and 1982). In 1979–1980, the Fed funds rate went from 11% in September to over 17% the following April—about 6 percentage points in just seven months. And, shortly after the Fed unwound that shock, it started raising rates again, from 9.6% in August 1980 to 19% in January 1981—three times as much as the current spike, and a lot faster. Of course, both of the Fed’s tightening episodes in the early 1980s ended in recessions, but it took a lot more tightening than we’ve seen so far this time around.
The US economy may be less sensitive to interest rates than it was in the past.2 Construction activity—the most interest-sensitive part of the economy—accounted for about 9% of GDP in 1980, but only about 7% in recent years. Spending on durable consumer goods (the most interest-sensitive portion of consumer spending) was running at about 10.5% of consumer spending before the pandemic, compared to 13% in 1980. Additionally, corporate balance sheets are quite healthy, with plenty of cash waiting to be spent. All of this means that the punch of higher interest rates is lighter than it was 40 years ago.
That’s why Deloitte’s US economic forecast does not include a recession in our baseline (figure 1). The baseline shows very slow GDP growth, if only because of the impact on the housing market. But our assumption that inflation is likely to moderate suggests that the Fed will stop tightening at a level quite a bit below what’s necessary to create a recession solely from high interest rates.
Of course, interest-sensitive sectors will feel very differently. Housing, in particular, has already started to decline. In our forecast, the continued fall in residential construction activity helps to slow GDP growth in 2023, especially over the first half of the year.
There is an old term—“growth recession”—that may describe what 2023 will feel like. The unemployment rate will rise slightly; job growth will moderate but won’t turn negative; and GDP growth will be below 1% through three-quarters of the year. Many parts of the economy will continue to grow, and employers will continue to face a relatively tight job market. Continued growth, even if it is painfully slow, means no recession. But the difference between that story and the story in which growth slows just a bit further—that is, the unemployment rate hits 4.5% or even 5% briefly—and an official recession is declared (perhaps in late 2023) is not much. Even forecasters who expect a recession don’t expect it to be very strong; the October Wall Street Journal survey of forecasters found an average 63% probability of a recession in 2023, but most forecasters expect the unemployment rate to remain below 5%.3 Such a mild recession would likely not derail the plans of many companies.
But … the chances of a real recession are significant. Against a background of geopolitical tensions, and a Fed that wishes to communicate its willingness to fight inflation, even a small financial shock could wreak havoc. As interest rates rise, investing institutions such as insurance companies and pension funds may need to revalue assets—and not in a good way. A corporate bond or mortgage paying 3% loses a lot of value when equivalent returns on newer assets are 6%. Suppose a systemically important financial institution finds too many of these low-interest-rate assets on its balance sheet. The problem isn’t that the assets are unsound; it’s simply the need to mark to market that could cause the type of problems that would lead to a full-scale recession. We have assigned a relatively high probability to our downside scenario where GDP falls significantly. We think that chances of such a recession are less than even. But businesses may wish to take action to guard against a potential hurricane even before one is sighted far off at sea.
Recession talk has ramped up over the past few weeks as the reasons to support the negative turn in sentiment stack up. The Bank of Canada has hiked interest rates by more than what we anticipated a few months ago—a trend that is chipping away at household purchasing power. Higher borrowing costs have created a headwind for businesses that want to invest. And aggressive monetary tightening isn’t limited to Canada: The European Central Bank and the US Federal Reserve are also embarking on rapid tightening campaigns. While a recession has been expected in the eurozone for months, the downgraded outlook for the United States will hit Canada hard, given its trade dependence on its southern neighbor.
Households are struggling under the double whammy of high inflation and rising borrowing costs. Higher interest rates had an almost immediate impact on the resale housing market, as elevated mortgage rates shrank the pool of potential buyers who qualify to borrow. As a result, we’ve seen household investments in real estate tumble since Q2 2022.4
Of course, higher interest rates are also pinching current borrowers. Recent data shows the impact on debt-carrying costs: In Q3 2022, interest payments on household debt increased by 16.2%—the largest jump on record.5 In dollar terms, interest payments increased by US$16.4 billion from the previous quarter.6 From an economics point of view, because consumption is the largest contributor to our GDP, that US$16.4 billion being redirected away from spending and saving is creating a notable headwind to growth. Given the increase in interest payments, it’s not terribly surprising that real household spending fell in the third quarter.7 Unfortunately, interest payments are set to continue to increase over the coming year, squeezing household budgets and leading to yet more declines in consumer spending.
In contrast, businesses continued to grow their investment spending in the latter part of 2022.8 Several factors contributed to this. Business investment is still playing catch-up from the last recession, and very strong growth in corporate profits in the pandemic’s aftermath is helping pad capital expenditure (capex) budgets. Further, labor has become increasingly scarce in Canada,9 creating an incentive to invest in productivity-enhancing capital to help offset staff shortages. Despite this, business sentiment has been trending downward over the past few months. It’s expected to remain subdued as the US economy slows further, and domestic consumer spending continues to decline. In addition, business inventories remain at an unsustainably high level, which will create a disincentive to invest in new capacity until the current stockpiles decline. So even though companies are expected to spend more, the gain will be modest because they’re also expected to take a cautious approach to investing over the next year.
Our forecast assumes that the Bank of Canada’s rate-hiking cycle has finished. At its current level of 4.25%,10 the overnight rate is high enough to be rapidly cooling growth but too high to be sustainable in the longer term. Indeed, our forecast predicts the steady diversion of household income toward interest payments and a US slowdown will drag Canadian economic growth for three consecutive quarters, resulting in an overall contraction of 0.9% this year. In response, inflation should decelerate sharply. This will allow the Bank of Canada to begin unwinding some of its restrictive monetary policy before the end of 2023. Rate cuts throughout 2024 will provide stimulus and allow for a modest recovery in activity, with a more robust rebound in store for 2025. While all this may sound quite dire, we still expect the recession to be relatively mild and short-lived by historical standards.
By Q3 2022, the Mexican economy had performed much better than anticipated, with GDP for the year expected to grow around 3%—well above the expected 1.8% in June. The economic progress has been mainly driven by robust growth in manufacturing activities and private consumption. Despite higher inflation that has eroded purchasing power, the recovery in the labor market and real wages, record-breaking remittances,11 as well as the increase in consumer credit have supported consumer spending.
Inflation has started to cool down in the last months of 2022 and should continue its downward trend over 2023―from 7.8% at the end of 2022 to 4.9% at the end of 2023. But the pace will be gradual and subject to risks. If this downward trajectory of inflation is fulfilled, the Bank of Mexico (Banxico) could have space to cut the reference rate during the second half of 2023 and be able to decouple from the US Fed. During the last six meetings, Banxico has replicated the increases made by the Fed, and we expect it to continue doing so at least until Q1 2023. This means that our terminal rate would be between 10.75% and 11.0%. Later in the year, we expect a decoupling and anticipate 150 basis points in accumulated cuts from Banxico, with the rate closing 2023 at around 9.25%.
Another big driver of growth during 2022 was the manufacturing sector, thanks to improving trade conditions and resilient US demand. As of October 2022, investment in machinery and equipment in Mexico was already 14.5% above levels seen in January 2020 (just before the pandemic hit), and 6% higher than in Q4 2018, when investments reached their peak. This means that companies have been involved in significant acquisitions of capital goods to increase their production. Also, construction of industrial plants and warehouses grew 12.7% over January–October 2022 compared to the same period in 2021. However, it is still 34% below Q4 2018 levels.
The strength in Mexico’s manufacturing sector may be related to recent supply chain and geopolitical issues around the globe. Some companies are producing more goods in Mexico to be nearer to final consumers in the United States. For example, since 2021, foreign direct investment (FDI) inflows have been increasing in specific states and sectors of the economy, especially in the cities bordering the United States. As of Q3 2022, FDI into Mexico reached US$32 billion—an increase of 29.5% compared to the same period in 2021.12 Those inward investment flows in Q3 were also 17.8% higher than the accumulated average Q3 flows between 2015 and 2019. Unsurprisingly, growth in the northern states doubled in most cases.
Employment has also increased significantly in the north and center-north of the country, where most of the manufacturing plants are based. Although the main product manufactured in Mexico is motor vehicles and parts (it is still 3% below prepandemic levels due to semiconductor shortages), the industrial sectors that are driving growth this time include electrical equipment (22% above January 2020), computer and electronic products (+10%), and plastics (+17%). This boom has resulted in manufacturing activities as a percentage of GDP to reach 17% from 15.9% in 2019 (figure 2). Also, Mexican participation in total US imports has increased (from 13.6% in 2018 to 15.2% as of October 2022, a net gain of US$38.4 billion), although it has not been able to capture the entire market share from China (from 21.2% to 18.2%, in the same period, a net loss of US$75.9 billion).
We expect growth to slip to 1.5% this year for a few reasons. First, inflation will erode households’ purchasing power and lift input costs for businesses. Second, interest rates will still be high, putting pressure on borrowing costs and dampening private sector credit. Third, fiscal austerity will do little to catapult growth. Fourth, the expected slowdown in the United States will weigh heavily on Mexico, given the strong trade and investment links between the two countries. On the upside, Mexico has a golden opportunity in the form of nearshoring, as it could drive investments, exports, and overall economic growth, especially in the manufacturing sector. Creating proper conditions to cash in on this opportunity, thus, becomes critical.
The UK economy has seen an earlier downturn than other major industrialized economies and faces a deeper recession than its peers. The same combination of excess demand, supply problems, and soaring energy that has driven inflation in the United States and the euro area has pushed UK inflation to double-digit levels last seen in the early 1980s.
The UK labor market ran hot through last year, with demand for labor outstripping supply and the unemployment rate hitting a 50-year low.13 Surveys by the British Chambers of Commerce show recruitment difficulties running at record levels. Faced with persistent and significant upside shocks on inflation, the Bank of England increased the pace of monetary tightening over the summer. From a low of 0.15% in December 2021, the bank raised rates to 3.5% by the end of 202214—the most rapid tightening of UK policy in more than 30 years. Rates will almost certainly rise still further in 2023. The economy is in recession and headline inflation has probably peaked for this cycle. Yet high core inflation and a tight labor market give the bank ample reasons to continue raising rates, which we see peaking at around the 4.5% mark by the middle of this year.
Tighter monetary policy, together with the dampening effects of high inflation, are starting to feed through the economy. The latest Deloitte CFO survey15 shows a softening in corporate hiring expectations. Job mobility, a classic sign of a strong job market, peaked over the summer and has since eased back. Unemployment is likely to follow suit, rising through 2023 and into 2024. The pressures on households are acute. The Bank of England expects real, post-tax incomes to fall in 2022 and 202316—by far the worst squeeze on disposable incomes since records first started to be collected in the 1950s.
The lagged effects of over 300 basis points of rate rises will be an increasing drag on activity in 2023. The January 2023 CFO Survey shows that major UK corporates now rate credit as being more expensive than at any time since 2009. Not since the financial crisis have CFOs rated bank borrowing and debt issuance as being less attractive than they do today. Corporate demand for credit is well below average levels and flagging. Meanwhile, rising mortgage rates have triggered a pronounced weakening in housing activity. After vertiginous growth over the last few years, house prices have fallen since September. With the recession likely to intensify, and pressures on households rising, house prices are set to fall further. We see UK house prices declining by about 15% from peak to trough in this downturn. Although this looks like a large adjustment, it would only return UK house prices to where they were in October 2020—and is far less than the 25% rise in prices seen in the last three years.17
UK fiscal policy has been buffeted by two changes of prime minister, from Boris Johnson to Liz Truss in September and from Liz Truss to Rishi Sunak in late October. Truss’ Chancellor, Kwasi Kwarteng, announced the largest tax cuts in 50 years18 and a major easing of fiscal policy in his budget statement in late September. The scale of the debt-financed tax cuts caused panic in the bond market and a sharp rise in the market interest rates on government’s private sector borrowing. The loss of confidence was also seen in the sharp decline in the pound, with the dollar rate dropping to the lowest level since 1984. The financial crisis triggered a political crisis which, in turn, led to Truss being replaced by Sunak.
Sunak’s government has presided over a return to orthodoxy with a tightening fiscal policy. Under the new government’s plans, public spending will come under pressure and the tax take is forecast to rise to its highest level since the Second World War. Another bout of public sector austerity looms, which will dampen growth. UK fiscal policy is in something of a bind. While the UK public sector is, with the exception of the pandemic, larger today as a share of GDP than at any time since 1975, voter satisfaction with public services, especially the National Health Service (NHS), is low. The next UK general election must take place by December 2024, with current opinion polls pointing to a Labour victory. Whichever party wins the next election will face a daunting combination of a large, but still stretched, public sector, high levels of taxation, and elevated public debt.
2023 will be a challenging year for the UK economy. We expect GDP to contract by 1.4% this year with the United Kingdom suffering a five-quarter recession of a similar magnitude to that of the early 1990s. This sort of performance would leave the United Kingdom as probably the weakest performing G7 economy. The country has been hard hit by the pandemic and rising inflation, but it also suffers from poor trend productivity. Brexit, by disrupting trade and investment, has acted as a further drag on UK growth.
The German economy was hit hard by numerous crises in 2022. The energy crisis, Germany’s geographical proximity to the war in Ukraine, skyrocketing inflation rates, and the economic downturn in its most important export markets resulted in an exceptionally high level of uncertainty. Consequently, consumer and business sentiment in Germany toward the end of 2022 came close to new record lows. Nevertheless, the German growth rate is solid with forecasts at 1.4% for the next year.
2023 will likely be another challenging year. Economic performance will crucially depend on the development of the war in Ukraine, as well as energy prices and inflation. However, a severe recession is not the baseline scenario. A mild recession combined with high inflation is the more likely macroeconomic challenge in 2023, with the second half of the year looking brighter than the first.
The current negative sentiments may exaggerate the threat of a severe recession. The key tail risk for the economy remains a rationing of gas due to shortages after the stoppage of Russian gas supplies in the summer of 2022. The gas shortages had impacted Germany more than most other European countries due to its high dependency on Russian gas and its energy-intensive industrial base. Rationing could result in production stops and a severe recession in Germany and Europe.
However, this scenario seems increasingly unlikely. Gas storages are filled, new LNG terminals have been completed or will be completed soon, and energy savings have already significantly reduced demand. A very cold winter still has the potential to change this outlook, but in a baseline scenario, Germany and the European Union (EU) should be able to avoid any major energy shortages this winter.
The labor market is another key factor currently stabilizing the economy. Despite concerns about a potential recession, the German labor market remains strong with a record number of employed persons and unemployment at a record low. According to the Deloitte CFO Survey, labor shortages continue to be one of the top three risks for businesses in Germany.19 While employment intentions may have decreased somewhat recently, this trend is likely due to a slowdown in employment growth rather than a sign of potential job losses. Demographic developments are a key driver for the tight labor market, which can be expected to persist.
Inflation in Germany and the eurozone was a significant economic shock in 2022 and efforts to address it are ongoing. By the end of 2022, inflation in Germany and the eurozone reached 10%. The primary drivers of inflation are on the supply side, in the form of energy costs and disrupted supply chains. Supply side–driven inflation is more challenging to combat than demand side–driven inflation, as central banks have no direct influence on its causes. The best they can do is to fight second-order effects and keep core inflation—inflation measured without energy and food prices—under control. In this regard, the results have been mixed, with core inflation at 5%—well above the European Central Bank’s 2% target.
Inflation declined somewhat in December (figure 3), but it is uncertain whether it has peaked. It is possible that inflation will continue to rise in early 2023 when households’ energy bills fully reflect energy price increases. In the second quarter, however, headline inflation will likely decrease due to baseline effects. Inflation had already accelerated in Q2 2022, thus increasing the baseline for inflation measurement for Q2 2023. The development of core versus headline inflation will be crucial to evaluate the expected price increases in 2023.
The European Central Bank’s response will critically depend on this spread of inflation. The central bank started its hike cycle in the summer of 2022, implementing four hikes totaling 250 basis points. The hike cycle is likely to continue in the first months of 2023 with smaller hikes in February, March, and May.
Following the sudden increase in prices, German consumer confidence had dropped to the lowest level on record in September.20 Consumer expenditure can therefore be expected to suffer, especially in Q1 2023. The outlook for world trade, which is crucial for the export-oriented German economy, is also bleak. The World Trade Organization estimates that trade will grow merely 1% in 2023, after 3.5% in 2022.21 The third factor for the economic outlook, corporate investments, are similarly unlikely to stimulate the economy, considering the high uncertainty. According to the Deloitte CFO Survey, plans for investment in the coming 12 months are in negative territory.
Taken together, this means that the winter will be particularly challenging due to high inflation rates and falling consumer expenditure, which will likely lead to the economy shrinking in the first quarter. Provided inflation decreases after the first quarter and consumer spending recovers, we should see a stabilization in the second quarter and a more positive second half of the year. However, the recovery will depend on the global economy, which will likely only grow modestly. The International Monetary Fund forecasts a growth rate of 2.7%, the weakest since 2001, outside of the financial crisis and the first wave of COVID-19.22 This indicates that the recovery is unlikely to be very dynamic, but more muted. The gas-supply situation could continue to remain fragile after the winter, particularly because Germany and Europe could struggle to fill their gas reserves without Russian gas in preparation for winter 2023–2024, leading to persistent uncertainty about the energy supply.
Our baseline scenario for the German economy in 2023 is a mild recession with a GDP contraction of –0.4% and an inflation rate of 7%. The challenge is perhaps not so much the recession, but rather the combination of economic stagnation and high inflation—also known as stagflation. The key questions for Germany’s economic performance in 2023 will be whether and how quickly inflation can be tamed, as well as how fast growth recovers following the winter recession.
Spanish GDP surprised to the upside in the second half of 2022 and is expected to grow further in 2023. The economy has shown resilience to recent headwinds, including the energy crisis, rising interest rates, and real wage loss. Consumption in real terms has kept growing, even though household and corporate confidence are weak, and production indicators are showing signs of slowdown. The relatively better position of the Spanish economy vis-à-vis the negative shocks hurting the eurozone is expected to place Spain above average for eurozone growth in 2023 (although with a moderate 1.5% growth in the baseline scenario), outperforming other major economies (Germany, France, and Italy).
Despite being one of the first economies to see inflation rise sharply, Spain stepped into 2023 with the lowest inflation figure in the eurozone. After five consecutive months of decelerating prices, inflation was just 5.7% higher year over year (YoY) in December.23 Headline inflation in 2023 is expected to be about half the level it was in 2022. Core inflation, nonetheless, is elevated (7% YoY in December)24 and is expected to remain so for several months before it starts to moderate.
Net employment is expected to continue to grow in 2023, although at a slower rate than in 2022, which will help broadly maintain the unemployment rate, currently at decade-low levels.25 As a result, consumption in 2023 is expected to decelerate. Although wage growth should be higher in 2023 than in 2022, inflation continues to erode purchasing power. For example, collective bargaining wage growth in 2022 was below 3%, while inflation was 8.4%.
2022 was the year in which higher interest rates returned to the eurozone after a decade of low inflation. The impact in Spain will be mitigated by the positive development of the labor market and the strength of households and businesses balance sheets relative to prior crises. For example, the private sector reduced its indebtedness from 226% of GDP at its financial crisis peak in 2011 to 152% currently (Q3 2022).26 Nonetheless, some families and businesses are vulnerable. The government has implemented various measures to cushion the impact, including energy and food tax exemptions, direct payments to lower-income households, a relaxation of certain mortgage terms via the banking sector, and support for severely impacted sectors.
The European Union Next Generation funds (€160 billion allocated to Spain between 2021 and 2026) will also be a pillar of growth, with the pace of spent funds expected to pick up this year, driving investment and providing the economy with an extra push.27 Strategic projects are being pursued in automotive, renewable energy, food supply chain, aerospace, microchips, shipping, and health. Emphasis is being placed on boosting Europe’s reindustrialization and strategic autonomy. Thus, the program is expected to boost key high-productivity Spanish industrial sectors and positively impact long-term growth.
The energy crisis, despite being a source of recession risk for Europe, is also the genesis of new medium-term opportunities for the Spanish economy. Spain has a chance to play a key role in European energy supply, given its renewable energy sources (sun and wind), geographic position, and existing infrastructure for gas supply, which can include renewable gas in the future. In October 2022, the German, French, and Spanish governments agreed to build undersea infrastructure to export green hydrogen from Spain to France and the rest of Europe.28 Although the project will take years to materialize and is not without significant risks, it is an example of such new opportunities.
The real estate sector performed strongly in 2021–22, with low interest rates and ample savings fueling higher prices and more transactions. However, the sector is poised for a slowdown in 2023. With accessibility progressively tightening and a constrained supply of homes, transactions are expected to fall in 2023, while price growth moderates. The real estate sector’s ability to weaken the rest of the economy should be limited, thanks in part to strong household balance sheets.
The flip side to the fiscal support offered to families and businesses is its impact on public finances, which were already unbalanced prior to the recent round of support. The fiscal deficit thus remains elevated, and although a slight reduction is expected in 2023, the deficit will remain above the 3% target. Debt is expected to drop slightly as a share of GDP, but by less than in 2022 and mostly due to nominal GDP growth. The suspension of the EU Stability & Growth Pact (EU Pact) enabled EU governments to spend above-usual targets to cushion the impact of COVID-19 and the conflict in Ukraine. However, new EU fiscal rules are expected to be reinstated in 2024, which will require Spain to set out on a path of fiscal consolidation from then on. The initial proposals put forward by the European Commission for the reformed EU Pact suggest the new framework might be more flexible than the previous one, allowing each EU member state a path adapted to their specific circumstances and favoring productive investments.
All in all, the Spanish economy is expected to decelerate in 2023, in line with the global outlook. Nonetheless, it is expected to maintain positive, though moderate, growth and halve inflation with respect to 2022, outperforming other European economies. At the same time, Spain is expected set out a path for forward-looking consolidation of public finances.
China’s management of COVID-19 saw a dramatic transformation at the end of 2022.29 The infrastructure of mass PCR (polymerase chain reaction) testing and movement tracking through telephone carriers were phased out swiftly. Even those who have not fully recovered from the virus are being encouraged to go back to work. China’s borders, which have effectively been closed for nearly three years, have reopened in 2023. Of course, the decision taken by the government to bring an end to the zero–COVID-19 policy raises questions over how the economy will perform as a result. Assuming adequate policy support, we still expect real GDP to grow between 4.5% and 5% this year.
As has been the case across the globe since the pandemic hit, there are trade-offs when it comes to loosening health restrictions. Dropping restrictions can boost economic growth, but if widespread illness occurs, economic activity can contract. Plus, people may decide to stay home to avoid the virus regardless of official restrictions. While consumers are still carefully gauging the impact of a flattening curve, economic data will likely stay sluggish, similar to what we have seen in November (as evidenced by the purchasing managers’ index, retail sales, and property investment data). As such, 2022 GDP growth might slightly undershoot our forecast of 3.5%. This is to be expected as it takes time for the general public, especially those who have not contracted COVID-19, to accept the risks related to the virus.
Leading up to the change in policy, the economy was already facing several headwinds unrelated to the pandemic, such as a deceleration of the property sector30 and slowing export growth31 (2023 could be a more difficult year for China’s external sector). Nonetheless, financial markets rewarded China’s swift decision by staging a major rally of almost all China-related financial instruments from the Hang Seng Index to the RMB exchange rate within weeks (figure 4).32 Investors’ rationale was simple—ending the zero–COVID-19 policy has underscored policymaker willingness to support economic growth.
At the most recent Central Economic Work Conference, policymakers identified three chief economic difficulties: weakening demand, supply chain shocks, and subdued expectations.33 If weakening demand is to be reversed, private investment must be jumpstarted while revenge consumption is needed. Supply chain stabilization is about improving the business environment against a geopolitical backdrop fraught with areas of contention. In concrete terms, this is about outcompeting other investment-led markets such as the ASEAN region and India, which may benefit from investment moving away from China. The good news is that financial investors’ expectations have significantly improved since the second week of November,34 thanks to the relaxation of COVID-19 restrictions and stepped-up policy support to the ailing property sector. Relaxing COVID-19 management controls is not only about demonstrating policymakers’ capacity to weigh the acute trade-off between economic growth and public health, but it is also a powerful move to dispel investor doubts about the priority of economic development as part of China’s overall policy agenda.
The main risk faced by consumers remains the uncertainties stemming from the property market, not because the sector presents a systemic risk (the Chinese government has the means to prevent such risk), but because consumers might increase their savings if they do not see much upside to holding real estate as a financial asset. Encouraging a rise in homeownership without stoking a housing bubble becomes the key challenge.
The long-term solution is for local governments to move away from relying on land sales as their main source of revenue, but such a shift could only be made gradually under the precondition of developing a viable municipal bond market. In the short run, a stable housing market will be necessary. In practice, this means support to complete unfinished projects, incentives for healthy developers to increase investment, and industry consolidation. This is a tall order, but liquidity has returned to offshore US dollar bond markets within a short period of time on the back of a slew of policy support from liquidity injections, debt issuance, and revived equity listing options.35
Assuming the property market stabilizes, stronger property developers will emerge on the back of further policy support and the People’s Bank of China's accommodative monetary stance. With the Fed heading to the final innings of its tightening campaign, China's monetary easing certainly faces fewer constraints. This is particularly true as the USD/CNY hovers around 7.0, compared to 7.3 two months ago.
We think a focused approach of promoting consumption and continued accommodative monetary stance are likely while a major fiscal stimulus would be ruled out in 2023. However, the biggest hurdle remains reviving private investment beyond the property sector. That is why the Central Economic Work Conference prominently emphasized the role of the private sector.36 Platforms were singled out for their key roles in helping Chinese companies develop and internationalize their operations. We anticipate that concrete measures will be unveiled following such signals, such as the tutoring sector being rehabilitated. The underlying point is that policymakers appear to have a sense of urgency to boost consumption and private investment as external demand could face a more challenging environment in 2023. All in all, we see 2023 GDP growth narrowly exceeding our original forecast of 4.5%.
We step into 2023 with continued uncertainties in global geopolitics and the world economic outlook turning less favorable. Amid chaos and anxiety, India’s economic outlook remains optimistic for this year and the next. Of course, growth may not be touching the numbers we had expected this time last year, but who knew then that the world would witness a series of shocks one after the other.
India’s economy has outperformed numerous economies over the past year. India’s equity market performance, the strength of its currency, and the foreign reserve cushion have done fairly well, compared to its emerging-market peers.37 In the growth-inflation dynamics, India is way ahead in growth among its peers, but inflation is a concern.
Economic indicators point to resilience of the domestic economy, even as the rest of the world sees an economic slowdown. Private sector balance sheets have improved over the past couple of years. This implies that the private sector can boost capex as and when the investment cycle picks up. Corporate deleveraging has also improved banks’ balance sheets, aiding the banking system to come out of the asset quality cycle.
High tax collections give the government ammunition to spend and cushion the impact of the impending global slowdown. Consumer demand remains strong, especially among the affluent, as is evident from the retail industry and the better profit performance of consumer discretionary goods companies in recent quarters.38 A strong rise in labor force participation and jobs points to a resilient labor market.39
What is interesting is that some global headwinds have played to India’s advantage. For instance, geopolitical developments are influencing trade relationships and disrupting supply chains. Nations and multinationals are emphasizing resilience, diversification, and self-sufficiency.40 India has huge potential as an export hub and investment destination in light of the China Plus One strategy, especially in the manufacturing and services sectors, where it has competencies and comparative advantage.
India’s recent trade agreements have aimed at integrating the manufacturing sector with the global supply chain while attracting investments in sectors that are expected to drive long-term growth.41 Consequently, there has been a healthy rise in FDI equity flows from Japan, Singapore, the United Kingdom, and the United Arab Emirates in H1 FY2022–23, even as FDI from the United States has fallen. If the trend continues, investment from these destinations will exceed numbers from last year, which was among the strongest on record. The destination sectors have also diversified, with infrastructure, non-IT services, and chemicals witnessing ample inflows. This shows that globally, there is rising confidence about investing in India.42
Low asset values have also allowed healthy companies to consolidate positions and enter new segments. A record number of M&A deals were registered in 2022 with the biggest transactions seen in the banking, infrastructure and materials, and aviation industries. Many conglomerates entered new businesses, while brick-and-mortar companies partnered with technology firms.43
Despite the relatively good economic news, the path ahead will still come with challenges. First, although we believe that inflation has peaked, it is expected to persist for longer, due to relatively high oil prices, a stronger US dollar, and supply chain interruptions in certain industries. Further, a relatively stronger economic recovery may add to the inflationary pressure.
Second, aggressive tightening of monetary policies across the central banks of advanced economies is resulting in a slowdown across major economies this year. This could impact domestic investment and consumer demand as the proclivity to save increases. Tighter liquidity conditions may also result in capital outflows and a rising imbalance in the balance of payments.
Third, job creation has improved lately but not to the extent that wage growth is running ahead of inflation. Opportunities and wage growth remain low, impacting the low- and middle-income populations. The government’s focus has rightly been on sectors that create jobs for workers across all skills, such as infrastructure, construction, and manufacturing. However, the services sector has huge potential as it contributes to 55% of GDP. India also has the competency and a comparative advantage in a few services such as IT and IT-enabled services. Yet, the service sector generates slightly more than a third of total employment.44
We believe the path to recovery will be resilient even if it is longer than previously anticipated. Investments will likely be a key driver of growth, primarily thanks to the government sector’s capital spending. However, the private sector may take some time to join the investment bandwagon. Given that the economy turned out to be weaker in H1 FY2022–23 than we had anticipated, we have revised our outlook. India is likely to grow in the range of 6.5–6.9% in FY 2022–23 and 5.8–6.3% in FY 2023–24.45 Inflation will come down but remain above the Reserve Bank of India’s comfort level.
What will be critical is to stay prepared for the time when the global economy recovers. India must do what it takes to keep the economic fundamentals strong; it will not only help the country stay ahead of its peers in the investment race but, will also aid in a quick economic rebound when uncertainties subside.
Like central banks in other advanced economies, the Reserve Bank of Australia (RBA) raised interest rates sharply through 2022 to quell an acceleration in inflation. However, with the high likelihood that inflation has already peaked, Deloitte Access Economics’ view is that any further increases in the cash rate are likely to unnecessarily tip Australia into recession in 2023. That forecast is dominated by the outlook for two important components of the economy—household consumption and dwelling investment. Both remained remarkably resilient throughout 2022 but are likely to weaken dramatically in 2023.
Real consumer spending has outpaced the wider economy. Recent gains have been fuelled by pent-up demand for travel. But this isn’t expected to last. The outlook for consumer spending has softened as high inflation and rising interest rates combine to add to cost-of-living pressures. Further, the full impact of the RBA’s current interest rate hike cycle is yet to be felt in the form of larger monthly mortgage repayments by households. Falling dwelling values are also weighing on household wealth.
Meanwhile, measures of consumer confidence have fallen to the lows experienced during lockdowns in 2020.46 The tight labor market is likely to continue to support nominal wage gains, but real wages are likely to remain under pressure. Growth in consumer spending through 2023 is highly likely to be much slower than in 2022.
Australia is also experiencing the fastest housing market correction since monthly records began in 1980. Sharp rises in borrowing costs from mid-2022 have reduced the amount homebuyers are willing and able to spend on new dwellings, with the value of new lending falling to its lowest level since late 2020. Weaker prices have hurt investment as developers typically respond by building fewer dwellings. The number of dwelling units approved—a key forward-looking measure of building activity—fell at double-digit rates over the past year, and building approvals remain around one-third below the peak seen in early 2021.47
The softer outlook is yet to materially ease the pressure on the residential construction industry caused by bottlenecks in the supply of labor and materials. Steel and timber shortages are persisting and upward pressure on wages is adding to labor costs, while wet weather and COVID-19–related absences are disrupting activity and prolonging construction timeframes. This has contributed to a 20% increase in the cost of building a new house over the past year, while the cost of building other residential dwellings has increased by almost 10%.
Housing also remains the largest source of inflation, contributing around one-third of price growth on average over the last four quarters. More recently, as inflation in residential building costs has decelerated, higher household gas and electricity bills have contributed more strongly to growth in the consumer price index (CPI) for housing. Outside of housing, inflation continues to be predominantly driven by goods rather than services, with prices of the former growing at more than twice the rate (9.6%) of the latter (4.1%) over the year to September 2022.48 Indeed, Australia’s inflation continues to be largely imported, with import prices growing 18.7% over the year to September 2022. However, business inventories have normalized from pandemic-era disruptions and indexes of shipping costs are consistently falling. Softening global demand will also provide space for supply to catch up. Inflation likely peaked over the year to the December quarter of 2022 at around 7.8% and will likely slow—although gradually—through 2023.
There are also some clear positives for the Australian economy. For one, the labor market is in extraordinarily good health. There are more than 200,000 fewer Australians unemployed now than before the onset of COVID-19 in February 2020 and the unemployment rate sits at just 3.4%.49 The underutilization rate, which captures both those wanting work (the unemployed) and those wanting more hours of work (the underemployed), has fallen to its lowest point since the early 1980s. However, the rapid, postlockdown growth in the labor market seen over the past year is nearing its end, with evidence of a turning point showing up across several indicators. The pace of employment increases has slowed and indicators of labor demand, job vacancies, and advertisements have started to decline. Going forward, employment is expected to grow through 2023, although at a declining rate. However, the unemployment rate is expected to rise slightly in 2023 as the labor force grows faster than total employment.
Second, commodity prices have remained higher for longer than expected, providing a welcome boost to Australian exports, business profits, and government budgets. The value of Australia’s goods exports rose in the latter half of 2022, despite the slowdown in the global economy and weather-related disruptions at ports in eastern Australia. That’s because the war in Ukraine continued to affect global supply chains and place upward pressure on prices for Australian food and energy exports. However, these windfall gains were always expected to be temporary. The correction in energy markets may be relatively slow, but lower prices are already flowing through to nonenergy commodity exports such as iron ore, coking coal, and other metals.
A combination of strong demand and higher prices has also added to the nominal value of goods imports. But the outlook for those imports has softened. The easing of price pressures is set to weigh on import values, while the forecasted slowdown in Australian consumer spending is expected to weigh on import volumes.
We expect Japan’s economy to be on its way to a sustainable recovery through 2023. The recovery is partly aided by the complete lifting of COVID-19–related social restrictions last year, which lagged one year behind those of America and Europe, and partly because of the continuing accommodative monetary policy by the Bank of Japan (BoJ), while the other central banks in developed economies are taking tighter monetary policies to fight against inflation. As a result, we expect Japan’s real GDP to grow 1.7% in 2023, accelerating from an expected growth of 1.3% in 2022. Domestic personal consumption and business investment will lead the economic expansion as social mobility comes back, and government stimulus spending continues. In addition, corporate profits were at a record high in 2022. Semiconductor supply constraints are easing, which is good news for Japanese manufacturers. We also expect that the BoJ will maintain its Qualitative and Quantitative Easing (QQE) program through at least the end of 2023, given that the underlying consumer inflation rate is below the bank’s target of 2%.
Nevertheless, a few factors complicate the relatively optimistic outlook, and risks are weighted to the downside. To begin with, the robustness of Japan’s economic recovery is relative. The rebound from COVID-19–related social restrictions has been strong, but real GDP remains below its prepandemic peak. The momentum of this rebound will ultimately subside, bringing the growth rate back toward its potential, which is below 1%.50
In addition, Japan’s economy is generally vulnerable to the rest of the world. The moderation of China’s economic growth and supply chain constraints have already affected Japan’s trade balance, which recorded negative net exports for more than 12 consecutive months (figure 5).51 If China’s economy deteriorates further, or if the United States or European economies go into recession, that may create more significant downward pressures.
Lastly, the BoJ’s monetary policy outlook has become more uncertain than before. At the December 2022 Monetary Policy Meeting, the BoJ surprised the market by unexpectedly relaxing the range of the 10-year Japanese government bond (JGB) yield target, from ±0.25% to ±0.50%. This effectively allows the 10-year yield to go up 0.25 basis points higher than before.52 This was, as Governor Haruhiko Kuroda stated, intended to normalize the currently skewed yield curve of JGBs, and not any indication of its intention for further tightening nor the exit from its QQE policy. Our baseline scenario continues to indicate that the BoJ will maintain the QQE policy at least through 2023. However, the decision to change the target range could prompt market speculation that the BoJ will give up its yield curve control sooner than the market had expected. The speculation might cause the Japanese yen to appreciate, which would relax Japan’s inflationary pressure. Perhaps more importantly, such a change would damage the competitiveness of Japanese exporters, which would lead to further widening of the country’s trade deficits.
Still, we are inclined to see the sunny side in the long run. Although the global economy may be falling on hard times while economic and political risks persist, there are fewer “bubble” aspects in the economy than we had before the Global Financial Crisis. This bolsters the case that a global recession next year will be relatively short and shallow. There will still be sufficient aggregate demand once supply side constraints ease. Plus, more investment opportunities lie ahead with the push toward renewable energy and digitalization.
The risks of a global slowdown, together with ongoing local challenges such as severe power cuts, the cost-of-living squeeze, slow investment, sluggish pace of reforms, extreme weather events, logistical constraints, and political uncertainty will weigh on South Africa’s growth outlook in 2023. Real GDP growth is expected to slow from an estimated 2.5% in 2022 to 0.3% in 2023, according to estimates released by the South African Reserve Bank in January 2023.53
While inflation already quickened toward the end of 2021, since Q1 2022, South Africa’s headline inflation has been driven by global price increases in food and fuel. This has affected the cost of living drastically, with household spending growth in October 2022 estimated to be less than 3% in 2022, and only 1.7% over the three years from 2022 to 2024.54
Financial stress is a key concern for South Africans, given the cost-of-living squeeze: South African consumers surveyed by Deloitte at the end of December 2022 noted that they are delaying large purchases (50%), feel their financial situation has worsened over the past year (39%), and are concerned about their credit card debt (38%) and about making upcoming payments (25%).55
Although headline inflation (which peaked at a 13-year high of 7.8% YoY in July 2022)56 is expected to moderate this year as food and fuel prices ease globally, the pressure on core inflation, which has been more subdued, could increase in 2023 as higher input costs are passed on to consumers. For example, producer price inflation for manufactured goods came in at 15% YoY in November 2022.57
Rising inflation saw an aggressive monetary policy tightening cycle (eight consecutive rate hikes since November 2021) by the South African Reserve Bank, which is likely to end in the first half of 2023, as inflation is reined in. Yet higher prices and lending rates, together with softer global commodity prices and the possibility of key advanced economies and trading partners entering a recession in 2023, will be a drag on South Africa’s growth outlook.
Compounding this locally is the difficulty to keep the lights on and power the economy, with disruptions to operations and supply chains as well as limited business confidence delaying investments and net employment creation. In terms of foregone GDP from power cuts, 2022 was South Africa’s worst year on record.58 And with severe power cuts continuing into 2023—expected to reduce growth by as much as 2 percentage points in 202259—the need to address this adequately is urgent. So too is the need for implementing growth-enhancing reforms to address structural bottlenecks and to spur expansion in job-creating sectors as unemployment remains unacceptably high (above 30%).
Fortunately, the country’s fiscal position has improved over the past two years. Fiscal consolidation measures such as budget discipline, together with better-than-expected tax collections, primarily driven by global commodities demand, have brought down the budget deficit last year. Smaller deficits are forecast for the next three years, with a primary budget surplus (i.e., excluding interest payments) penciled in for 2023–24 (figure 6).60 Rightfully, the revenue windfalls are being used to reduce elevated government debt and to support reforms at crucial state-owned enterprises (SOEs). But fiscal risks (on both the expenditure and revenue side) continue to loom.
With a focus on fiscal consolidation, already low public investment has however declined further. Indeed, overall investment has been declining in recent years, with gross fixed capital formation still below prepandemic levels. Yet, government spending on infrastructure, including roads, rail, and water projects, is expected to almost double during the 2022–23 to 2025–26 budget period, although from a low base.61 And energy sector reforms under Operation Vulindlela are expected to encourage private investment.
Creating an enabling environment conducive to investment, both domestic and foreign, including political and policy certainty in the run up to the 2024 general elections will be an important foundation for the structural changes needed in the South African economy in the medium term.
What could be a game changer for the country is leveraging the opportunities linked to its own energy transition goals (a move away from a coal-dominated energy mix while overcoming its power generation shortfalls) as well as supplying and adding value to critical commodities in a global clean energy future. On the former, South Africa has massive renewables potential, not only in solar and wind, but also in green hydrogen. On the latter, it also has a notable comparative advantage in supplying key minerals and metals for clean energy applications. For example, this includes platinum group metals (used in catalytic agents in hydrogen electrolysis and fuel-cell applications), vanadium (input for long-duration battery energy storage applications), rare earth elements (used in permanent magnets in the electrical motors of wind turbines and in electric vehicle motors), and nickel (applications in EVs and battery storage, and hydrogen and geothermal technologies).62 This could help give rise to new drivers of economic activity that boost growth and create jobs, while also ensuring a just and fair transition toward carbon neutrality.
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View in ArticleThe authors would like to thank Timo Walter, Claire Wen Xu Rao, and Alessandra Ortiz for their incredibly useful insights. They would also like to extend their thanks to Michael Wolf for managing the production of the paper.
Cover image by: Jaime Austin
